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Rosenberg: Stock picking? Here's where to start looking

The Canadian corporate earnings backdrop has been dismal to say the least and analyst revisions have been coming down fast and furious.

It looks as if earnings per share for the TSX equity space shrank more than 10 per cent in 2015, though there was a very heavy skew due to energy (down 68 per cent year over year) and materials (off 26 per cent). There were actually earnings gains recorded elsewhere, led by health care (up 48 per cent year over year), staples (19 per cent), industrials (16 per cent), discretionary (15 per cent), utilities (7 per cent), tech (5 per cent), telecom (4 per cent) and financials (1.5 per cent).

For the coming year, even as analysts have been cutting their numbers (by more than 6 per cent over the past month alone and 10 per cent over the past three months), there is again a concentration in energy – looking to be weak with earnings per share at minus 30 per cent for this year – but gains elsewhere are anticipated to push the overall earnings tally back into positive growth terrain – about 10 per cent.

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The reason? Materials are looking to rebound (up 10 per cent) thanks to the rally in gold and the apparent bottoming in the base metals complex, and health care is looking to lead again (45 per cent), though this is a one-trick pony (as well, health care's weighting in the TSX is smaller than that of the S&P 500). Health care is followed by consumer discretionary (up 20 per cent), consumer staples (15 per cent) and tech (15 per cent). Utilities (up 10 per cent), financials (8 per cent), telecom (5 per cent) and industrials (5 per cent) are looking to show more modest, but decent, advances.

As for how we are positioning ourselves, we are being quite cautious and recognize that the Canadian market has become increasingly idiosyncratic and name-specific. It is always a stock pickers' market, but now more than normal.

While the earnings outlook is better now than it was a year ago, it is because of a tenuous trough in the basic materials complex, capital-expenditure retrenchment, dividend cuts and asset sales.

The market has rallied on these developments, but the "buying power" seems to have come largely from a closing of some very large short positions.

What we are avoiding most is any business that has an orientation toward Alberta and Saskatchewan, where recessionary pressures are deepening. Oil services are a classic example. Others include banks that have exposure there, and not just to energy – as unemployment mounts in that part of the country, we are concerned about exposures to consumer credit, too.

The banks command a very juicy yield and trade at cheap multiples but against their own history – not globally. Still, we await the chance to buy at better levels once we see earnings visibility get restored to a small extent. Financials are priced attractively, but there is valid concern on how bad the loan losses will prove to be as a dead-weight drag on expected 2016 earnings (though it is encouraging to be seeing analysts ease up on earnings downgrades for the financials over the past month).

For now, we favour banks with low exposure to Western Canada, low exposure to oil and high exposure to the U.S. market. Certain Canadian banks fit this bill better than others – this a prime theme as the recession pressures in the West intensify; companies with outsized Alberta exposure are to be avoided like the plague.

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We do like the food-inflation theme in Canada, courtesy of a 70-cent-plus Canadian dollar, and as such see the grocery chains as having some decent pricing power. Tax cuts for low-income households will favour retailers that cater to this group.

There are certain industrials and transports that we like, given the super competitive exchange rate and decent domestic demand growth south of the border.

Given the Bank of Canada's commitment to maintaining ultra-low rates, there are a select group of Canadian REITs that have cheapened up to attractive levels – we could not say that a year ago – but avoid those in the oil-sensitive provinces.

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

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